Europe’s Brush with Debt

MUNICH – French Prime Minister Manuel Valls and his Italian counterpart, Matteo Renzi, have declared – or at least insinuated – that they will not comply with the fiscal compact to which all of the eurozone’s member countries agreed in 2012; instead, they intend to run up fresh debts. Their stance highlights a fundamental flaw in the structure of the European Monetary Union – one that Europe’s leaders must recognize and address before it is too late.

The fiscal compact – formally the Treaty on Stability, Coordination, and Governance in the Economic and Monetary Union – was the quid pro quo for Germany to approve the European Stability Mechanism (ESM), which was essentially a collective bailout package. The compact sets a strict ceiling for a country’s structural budget deficit and stipulates that public-debt ratios in excess of 60% of GDP must be reduced yearly by one-twentieth of the difference between the current ratio and the target.

Yet France’s debt/GDP ratio will rise to 96% by the end of this year, from 91% in 2012, while Italy’s will reach 135%, up from 127% in 2012. The effective renunciation of the fiscal compact by Valls and Renzi suggests that these ratios will rise even further in the coming years.

In this context, eurozone leaders must ask themselves tough questions about the sustainability of the current system for managing debt in the EMU. They should begin by considering the two possible models for ensuring stability and debt sustainability in a monetary union: the mutualization model and the liability model.